Richard K. Matros has been Chairman of the Board and Chief Executive Officer of Sun Healthcare Group, Inc. since 2001. Mr. Matros served as Chief Executive Officer and President of Bright Now! Dental from 1998 to 2000. He served Regency Health Services, Inc., a publicly held long-term care operator, as Chief Executive Officer from 1995 to 1997, as President and a director from 1994 to 1997, and as Chief Operating Officer from 1994 to 1995. He served Care Enterprises, Inc. as Chief Executive Officer during 1994, as President, Chief Operating Officer and a director from 1991 to 1994, and as Executive Vice President—Operations from 1988 to 1991. Mr. Matros currently serves on the Executive Committee of the Alliance for Quality Nursing Home Care, a Washington, D.C. based advocacy group for the long term healthcare industry, on the board of directors of Bright Now! Dental and on the Advisory Committee of Aviv Asset Management, LLC.

Steve Monroe: I’m here with Rick Matros. He’s a CEO of Sun Healthcare Group. Rick, health care and insurance reform may be coming sooner or later. But even if it doesn’t, there’s going to be a lot of pressure on Medicare rates for skilled nursing facilities. What can Sun Health and other providers do to make sure that decreases in reimbursement or even flat rates do not impact quality of care at your facilities?

Rick Matros: Well, it’s a good question, because it’s a fine line between cutting providers and having it impact beneficiaries. But what we’ve been trying to do proactively in DC is spending time with leadership on the Hill, both in the Senate and the House, because they are looking for sectors who are supportive of health care reform to work with them on coming up with how much each sector is willing to give in order to contribute to pay for the cost of health care reform. And so, we’ve been doing that.

And in the Senate bill that came out last week, the Senate has us in for $14.6 billion in cuts over ten years. We’d like to think we can improve upon that. But it’s a better place than we were before that. And essentially, because these are ten-year deals, that actually gives us more visibility to our rates than we’ve ever had before. So, in this specific case, our market basket will be kept whole during that period of time, but we have what they call a productivity adjustment that reduces the market basket in that prior to the adjustments and apply it to all providers. And that’s effective fiscal year 2012 through the remaining eight years of this ten-year period. And prior to the adjustment, approximately 1 percent, so we can look at that and say, okay, over the next several years, we’re going to get our full market basket minus about 100 basis points.

And so, really, even in the context of everything that’s going on in health care reform, we’ve never had that much visibility before. Every year, it’s kind of a battle, at least in the MedPAC recommendations and this one’s going over budgets and all this sort of thing on the Medicare side. Medicaid’s a different issue. So, whether you a believe a deal is going to be good for ten years or not, even at least over the next several years it gives us visibility as operators. And I think it gives the investment community and the capital markets community visibility to us that we’ve actually never had before.

Steve Monroe: And at least you’re going to know what your reimbursement will be. It won’t be every year of the unknown.

Rick Matros: Exactly. So, even though we won’t get a full market basket for most of those years, we now know what we’re going to get, and it’s easier to plan around that. But that said, we are taking a hit right now effective October 1st on Medicare and have had a terrible Medicaid rate environment, because the state economy is in some, like many others, have announced some pretty significant infrastructure cuts over the last couple of months, including layoffs. And at this point, we have restricted those layoffs to corporate overhead.

We’re going to do everything we can not to impact anything at the facility level so that there isn’t an impact on patient care. And to that end, when we look at the totality of Medicare cuts from the forecast error correction, the Medicaid rate environment, we’re taking a $22 million revenue hit next year. We’re offsetting that with $10 million in infrastructure cuts. But in order to preserve quality of care, we’re basically going to take a hit to the bottom line. And fortunately for us, we’ve gotten healthy enough that we can do that and hopefully, as we go into 2011, look for some growth again.

Steve Monroe: And higher acuity, as we all know, has been the way to go for skilled nursing facilities for a while, but with Medicare reimbursement obviously going to be tighter going forward, is there any other area of senior care that skilled nursing providers can move into to kind of complement what you’re doing?

Rick Matros: There really isn’t. And I think even if you assumed rates get a little bit tighter or they move rates around within the system, as in contemplating RUGs IV, the sickest patients are still going to bring in the best reimbursement. And everything that the government’s doing and CMS is doing is moving patients down the continuum. And whether you look at the changes to RUGs or the 60 percent rule, some of the things they’ve done with LTAC reimbursement, now they’ve got demonstration projects going on for uniform patient assessment tools, which we’re very supportive of.

So, regardless of how things move around within that rate structure, we’re still – our best strategy still is to take care of the higher acuity patients. And it does a couple of things. It isn’t just a reimbursement or a margin issue, but in those communities where we are starting to excel at taking care of these short-stay patients for three or four weeks and then sending them home to a lower level of care, we’re changing the image of nursing homes, nursing centers in those communities.

And so, for us, for example, the dynamic is really dramatic. About 20 percent of our patient base is short-stay patients. It’s 40 percent of our revenue. It’s 80 percent of our admissions. And so, you can see over a period of years that will continue to sort of migrate in that direction, except maybe for really rural communities where there aren’t very many options. The nursing home really will become a nursing and rehab center primarily for the short-stay patient as those long-term care patients that we’ve always taken care of sort of reach end of life and we’re admitting less of those. It really changes the business model pretty dramatically and saves the system quite a bit of money as well.

Steve Monroe: Well, talk about end of life. In the past years, you guys have done some Hospice acquisitions. I don’t know if you’ve done any recently. I haven’t seen them. But is that a business that you want to grow some more? Or is that going to get hurt by reimbursement and just you’re going to maintain the status quo?

Rick Matros: No, we’d actually like to grow aggressively and to be doing more acquisitions, but in this credit market, there just hasn’t been much product out there. I think as soon as the market clears out a little bit and those opportunities are there, you’ll see us get more assertive in terms of looking for those kinds of opportunities. Hospice is very synergistic with nursing homes. It’s a great complement to what we do. Every one of our nursing centers has Hospice contracts. So, if we don’t have our own Hospice, someone else is getting that business.

And in terms of the system changing from a reimbursement perspective, it’s inevitable. But it needs a complete overall, because it’s very antiquated. A Medicare cap was put in place whenever, 20 years ago, however long it’s been, and it just doesn’t make any sense any longer. So, my guess is everything’s becoming more episodic in nature from a reimbursement perspective. That’s probably the way Hospice goes. I think Hospice is a healthy enough business financially that even if there’s some compression on the margins for the new reimbursement system, it’s still going to be a business that will be attractive.

Steve Monroe: How about skilled nursing, are you still in the market? I know the credit markets are tough. Are you still in the market looking for actual facilities or portfolios of facilities?

Rick Matros: We are starting to look again. But still, there’s not much out there at this point. But we’ll look for larger deals when the time comes, because one of the things for Sun that we have to mindful of is we have a very inexpensive credit facility that we put in place when things were really good. And we will never see money that cheap again. And our credit facility doesn’t mature until 2014.

Steve Monroe: Oh, that’s long maturity.

Rick Matros: Right. So, we really need to be mindful of that, because if you do a large deal, you’ve got to get permission from your lenders, and the price of that permission is resetting your credit facility to current market. And so, you don’t want to do that unless whatever deal you were looking at is so compelling that it makes it worth it to do, because if your interest rate’s going to go up two or three hundred basis points, it better be a good deal.

Steve Monroe: No one is predicting a return to full employment any time in the next several years. Is the current employment market benefiting you at all? Or just too early to really tell – in terms of wage rates and just hiring people out there, nurses, LPNs?

Rick Matros: Yeah, it’s benefited us a little bit. Not as much as it would have say ten years ago if we had the same economic environment, because there are so many more options now for nurses and therapists. But that said, it has helped our retention. Wage inflation has been quite a bit lower than it’s been historically for us. But the real shame of this whole thing in terms of rate cuts at the nursing homes is that we’re the one sector that today, we have the capacity as a sector to employ 100,000 more employees across the country. So, we should be an industry that’s helping the unemployment situation in the United States. And instead, because of the rate environment, we’re cutting back also.

Steve Monroe: And which probably is going to take a long time for Washington to understand that one.

Rick Matros: We’re trying to convey that message to them.

Steve Monroe: I assume you have unions in some of your facilities on a state-by-state basis.

Rick Matros: We do.

Steve Monroe: Do you think that there’s going to be any kind of a stealth Card Check bill that’s going to come through Congress? Or I know the White House is kind of not in favor of doing that right now. But with some certain changes – I know Senator Arlen Specter is kind of pushing a different version of it. Do you think that’ll ever pass?

Rick Matros: I think there will be a lot of resistance to it. And to me, Card Check’s a little bit of a red herring. What I think is more important to the unions is mandatory arbitration. So, I think there is a little bit of a danger we’re being so focused on Card Check that the other sort of passes.

Steve Monroe: But isn’t the mandatory arbitration part of that? I thought that’s kind of Part B of it.

Rick Matros: It’s Part B of it that they could give up Card Check theoretically and still get mandatory arbitration in some sort of compromise.

Steve Monroe: Compromise.

Rick Matros: Right. And if you had to pick one, you’d rather have the Card Check without mandatory arbitration. But I think that our attitude has always been that if we do the right things by our employees they tend not to choose unions because management’s behaving appropriately and taking care of them. And for us, actually, even in this rate environment and the hit that we’re going to take economically next year, we’re actually going to be improving our benefit package, not all of them, for the majority of our employees. So, we’re trying to be real mindful of that.

Steve Monroe: Okay. And one thing I’ve never really understood, even with decent Medicare rates compared to Medicaid rates, skilled nursing facilities, it’s a good business, but skilled nursing facilities have never been a high margin business. After taxes, after everything, it’s always been earning a dollar or $2, $3 on every $100 of revenue. Why is it that Washington doesn’t get that it’s such a tightly run, low-margin business?

Rick Matros: Actually, I think Washington gets it better than you might think, because if you really look at the years since BBA, for example, which frankly this last decade is the first time in the history of our sector where we’ve actually had a consolidated and organized effort to try and educate and get our message across to DC. And so, really what you’ve seen these last seven or eight years are market baskets every year consistently regardless of what MedPAC recommends. Relatively consistent Medicaid rate increases, so we’re able to maintain that sort of low-margin business.

But our whole educational thing with the Hill is you can’t just look at Medicare margins; you have to look at total margins. And the Republicans have been in control for so long that they really understood that. And our challenge when the Democrats took control was to start over with that same educational process because they really had been in control of Congress for a very long time, since pre-BBA really. And these last two years, MedPAC made the same recommendation it always does: market basket freeze. And Congress allowed CMS to push through the market basket for us anyway. So, that bode well for us relative to us believing that people were understanding that if you talked to leadership in the House and the Senate they do understand that now.

We’d really like to and are trying to work with leadership on the Hill to broaden the MedPAC charter, whether it’s the current MedPAC or a newly envisioned super-MedPAC, to consider total margins when they make the recommendations and not just Medicare margins. And not just for us, but for everybody. We’re a little bit more unique, because there isn’t another health care sector that takes care of as many of the indigent and elderly as we do.

Steve Monroe: Well, as I heard this afternoon with the – what was it? The 594th amendment, whatever, that was passed in the Baucus bill.

Rick Matros: Correct. The [White] Amendment.

Steve Monroe: Right. Where they’re going to have consider Medicaid and Medicare together, which is – as you said, the first time that’s ever happened.

Rick Matros: Correct. We’ve worked I think really hard to try to make that happen. And we’re very appreciative actually of the support that we’ve gotten both in the Senate and the House on that.

Steve Monroe: So, the health care system in this country is going to have a lot of changes. Medicare for everyone is going to change to some degree. With all this happening, do you think there’s going to be some sort of structural change in the skilled nursing business? How you get paid, who the patients are, short-term versus long-term, do you see something really kind of evolving over the next five or ten years for a new kind of skilled nursing industry?

Rick Matros: Well, I think two answers to that. One, I do see something evolving, because I think there is I think it might be too strong of a word, but certainly a focus by CMS to push towards more of a uniform, neutral site payment system for the post-acute sector in total. And I think that one of the purposes of the demonstration project has been this uniform patient assessment tool. So, in other words, the rate at which a patient gets – if you get reimbursed for taking care of a patient, it should be based on their condition, their diagnosis, not of the setting that they’re in. And that’s something we would be supportive of.

But above and beyond that, our group has developed, I think, a very well thought out, complete reform of the long-term care financial system, not just nursing homes, but post-acute care and generally, and is very evenhanded in terms of how it treats anybody, so it’s not nursing home oriented, because we knew that would never pass muster. And we have begun to introduce that to leadership on the Hill and basically been told we need to get through all this stuff first, we don’t really have time to get to you guys right now. But as soon as we get through this, we’re interested in looking at your proposal. And so, we have gotten it to some key people.

Once we get through health care reform, we’ll be focused on trying to more aggressively introduce that, because even if at the end of the day however it turns out looks somewhat different, which I’m sure it will, with what we’re trying to introduce, what we’re really trying to accomplish here is to come across because we believe that we want to be part of the solution. They’re looking for help on the Hill.

Steve Monroe: They are looking for help?

Rick Matros: Yeah. Yeah, they’re looking for ideas. And they’re looking for feedback. And so we want to be part of the solution. We don’t want to just be an industry that’s in there saying don’t cut us or give us more. So, we’re trying to be a lot more proactive than historically this industry has ever been.

Steve Monroe: That’s good. Now, I’ve known you for I’d say almost 20 years or so. And I remember years ago I always thought of you as the pioneer for managed care and skilled nursing facilities in California. I think you probably had the highest managed care census of any large nursing home company. This was your company prior to Sun. And it was something that, you got it. Managed care came in, you understood it, you understood how to deal with them in the skilled nursing business. We don’t hear about managed care at all anymore. It’s all Medicare. What’s happened with managed care in the skilled nursing business? It’s not just blown away?

Rick Matros: No, I think you’ll start hearing more about it now, because post the end of the last decade, managed care in nursing homes kind of fell apart. First of all, from a pricing perspective, it became untenable. And a lot of us stopped doing business with managed care providers. And most of the managed care providers got out of the business for a long period of time. The only managed care provider of note that was still in business was PacifiCare with its Secure Horizons product. I mean, everybody else was just out of the business. And that’s really what happened. There was nobody buying product. With the advent of Medicare Advantage, it’s starting to become much stronger.

And while our managed care from a census perspective is only about three-and-a-half percent of our patients, that’s double what it was two-and-a-half years ago. And in our centers where we have these rehab recovery suites, which we’re more focused on the short-stay patient, our managed care census is double what it is in the rest of the company. And in those units themselves, it’s actually over 15 percent. So, we’re being a lot more aggressive working with the Medicare Advantage players out there, because those patients, the rate isn’t quite as high as the Medicare Part A rate, but it’s still a pretty good rate and we get acknowledged for the acuity that we provide. So, as long as we’re able to take care of higher acuity patients, we get better rates. And so, I think that’s something that you’ll see a lot of us going after a lot more aggressively.

One of the things that happened with us was we were starting to get more aggressive with it, and then, when we did the Harborside acquisition, Harborside just stayed away from managed care completely. So, it really diluted our numbers. And so, it’s almost been starting from scratch since we did that deal two-and-a-half years ago, because it’s about one-third of the company. Just sort of get that going and teach everybody again.

Steve Monroe: So what happens if – I mean, everyone in Congress is talking about cutting the Medicare Advantage rates. And so, if half of Medicare Advantage disappears, is that going to take you off the track of managed care with them, from where it is?

Rick Matros: Yeah, I don’t think half or anything like that’s going to disappear. Medicare Advantage Plans do pretty well. They may not want to take away a cut, no one does. But I think they’re still going to be in pretty decent shape. The question is if Medicare A gets cut, does that pass through Medicare Advantage, does that impact us? Because a lot of Medicare Advantage contracts are based on the RUGs rates.

And I think it just depends on the managed care provider that you’re doing business with. There are certain managed care providers that are going to say if we’re getting cut, we’re cutting our rates to you. And so, then the question is, is it still going to be worth it for you to do business with them? Are there other managed care providers in that community that you can do business with? But then, there are other managed care providers that actually have an attitude that’s more like, our biggest cost is the acute hospital and utilization within the acute hospital. And you guys can help us get that down if you can take this classification of patients three days sooner.

And so, I think what you will see is us being a little bit more particular about who we do business with, if in fact there are Medicare Advantage players out there who just want to pass it on to us as opposed to those who see us as helping them solve their bigger problem.

Steve Monroe: All right. Well, that’s been very informative. Thank you very much for sitting down with me.